The IRS Large Business and International Division (LB&I) has instructed its examiners that under some circumstances, they should not challenge a taxpayer's treatment of milestone payments made to investment bankers. The directive, LB&I-04-0413-002, issued April 29, provides that for taxable years ended on or after April 8, 2011, examiners should not challenge a taxpayer's treatment of an eligible milestone payment when:
- the taxpayer qualified for and timely elected the Rev. Proc. 2011-29 safe harbor for the covered transaction,
- the taxpayer has not deducted more than 70% of any eligible milestone payment incurred in connection with the respective success-based fee on its original tax return for the year in which the taxpayer's liability for the eligible milestone payment accrued, and
- the taxpayer is not contesting its liability for the eligible milestone payment.
In some instances, taxpayers incur milestone payments in a taxable year before a transaction closes and before the taxpayer is eligible to elect the safe harbor in Rev. Proc. 2011-29. In such instances, directive LB&I-04-0413-002 provides that examining agents should not challenge the taxpayer's treatment of an eligible milestone payment when the taxpayer has satisfied Nos. 2. and 3., has documented an intent to make the safe harbor election and actually makes the safe harbor election if the transaction successfully closes.
Rev. Proc. 2011-29 provides that taxpayers may make a safe harbor election to allocate success-based fees incurred in covered transactions. It permits taxpayers to elect to treat 70% of a success-based fee incurred in a covered transaction as an amount that does not facilitate the transaction and the remaining 30% as an amount that does facilitate the transaction for taxable years ending on or after April 8, 2011.
A July 2011 directive, LB&I-04-0511-012, instructs examining agents to not challenge a taxpayer's treatment of success-based fees paid or incurred in a covered transaction when the taxpayer capitalized at least 30% of success-based fees in covered transactions. Prior guidance issued by the IRS did not clearly indicate whether such milestone payments should be treated in the same manner as success-based fees or as nonsuccess-based fees.
Milestone payments, which are often nonrefundable, are made to investment bankers over the course of a transaction when certain events occur, even if the transaction as a whole is never consummated. The payments are often creditable against the banker's subsequent success-based fee, which is typically payable when the underlying transaction closes.
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